Investing in stocks great, but bonds can help

by William Creekbaum

There's an old Wall Street adage that says, "Make your money in stocks, but keep your money in bonds." With the market volatility investors have experienced over the past couple of years, it has been enough evidence for most investors to consider an overall portfolio strategy that solidly integrates stocks as well as bonds.

Most likely, the primary reason you purchased stocks was to achieve growth in your investment portfolio. But did you know that bonds could help you achieve a number of complimentary objectives? The three most important are to preserve capital, supplement current income and enhance total return.

When you purchase a bond, you're essentially lending money for a specific period of time, at a fixed rate of interest. Bonds are a reliable alternative to banks and other lenders who might demand less attractive financing terms than the capital markets are able to provide, such as a higher rate of interest. Ultimately, this cost savings benefits both taxpayers and shareholders by lowering the borrower's overall expenses.

Bonds are generally known as fixed-income securities since most pay a fixed rate of interest. As a result, falling interest rates make outstanding bonds more attractive, while conversely, rising interest rates cause fixed-income securities to lose principal value. Many investors like bonds, however, because regardless of a bond's fluctuating price during its lifetime, the principal of the bond is returned at face value when it matures.

Since the U.S. Treasury Department issues most government securities, bonds in this sector are commonly referred to as treasuries. Treasuries are considered the safest of all fixed-income securities and serve widely as the most important benchmark used by bond investors. The four most popular securities issued by the U.S. Treasury are bills, notes, bonds and TIPS.

U.S. federal agencies, which are fully owned by the government and Government Sponsored Enterprises collectively issue debt securities known as agencies. The implicit connection to the federal branch has led agencies to be considered second in credit quality only to U.S. government securities. Agencies use the proceeds to provide funding for a variety of public policy purposes such as housing, education and farming.

Mortgage bonds are securities created from mortgage loans. The loans have been derived from financial institutions providing financing for home loans and other real estate. Mortgage lenders typically package these loans and then sell them to mortgage bond issuers. At approximately $3.5 trillion in outstanding securities, mortgages are now a major segment of the U.S. bond market.

Private and public companies issue corporate bonds commonly known as corporates. Financial service companies, industrial concerns, transportation providers and utilities issue corporates.

Municipal bonds are issued by state, cities, counties and towns. The proceeds from bond sales are used for the building and maintenance of a variety of public works projects - such as the construction of schools, roads, hospitals and sports stadiums.

Other fixed-income securities you should know about include preferreds and certificates of deposit.

For more information, e-mail william.a.creekbaum@smithbarney.com or call 689-8700.

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Smith Barney does not provide tax and/or legal advice. Please consult your tax and/or legal advisors for such advice.

William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial-services firm serving Northern Nevada.